A Roth IRA is considered, by most financial experts to be the best investment for an individual’s retirement plan. A retirement account that promises tax-free growth and tax-free disbursements certainly sounds appealing. While Roth IRAs can be extremely valuable to most retirement investors it may not be true for everyone.
Some of the main advantages of a Roth IRA apply to young investors. You get no tax deduction as you contribute to a Roth IRA as you do with a traditional IRA. However, the disbursements are tax free after the age of fifty-nine. Young workers are typically at the beginning of their careers and in a lower tax bracket reducing their need for tax write-offs.
MSN Money points out how this is advantageous as your income increase through your life. “By then your income should be higher, in real dollars, than at, say, 25, so your tax rate is likely to be higher, too, making the back-end tax break more valuable than the front-end one.”
The other main advantage to a Roth IRA is flexibility as MSN Money points out, “Retirement is decades away and you might need cash sooner — to start a business, pay the rent while you return to school or for an emergency. Take money out of a pretax IRA or 401k before retirement and you can get hit with a 10 percent early withdrawal penalty, as well as ordinary income taxes.”
There are three disadvantages to the Roth IRA route that apply to certain people in certain financial situations.
First, your tax rate won’t get any higher if you are already in the highest tax bracket. Daily Finance explains how the tax trade-off with a Roth IRA doesn’t work for everyone. “If you’re in the prime of your career and have earnings that put you in the maximum tax bracket, the value of getting a tax deduction on traditional retirement-account contributions is extremely high. So using a Roth and giving up that deduction doesn’t make much sense. For those who are just getting started and are in low tax brackets, it’s a lot easier to justify giving up a smaller deduction now in exchange for big tax savings later.”
Second, a Roth IRA doesn’t offer one benefit of 401(k) plans. Most employers match their employee’s contribution to a certain point. When saving for retirement it makes sense to contribute enough to your 401(k) to receive the maximum matching funds from your employer. Any extra money available for saving should go into an IRA.
The third reason a Roth IRA may not be your best option is Washington D.C. Tax laws can change over the course of decades. What tax laws give, tax laws can take away. Daily Finance gives a good example of this. “The latest administration budget proposal would set maximums on the amount of tax-favored retirement savings that you can set aside, as well as other provisions that would impose required minimum distributions on Roth IRAs for the first time. Some analysts worry that more substantive changes could be next, including potentially adding a surtax to Roth IRA distributions to effectively remove their tax-free status.”